Fed: Low rates to stay till at least mid-2013

Three Fed officials dissent for the first time in almost two decades

WASHINGTON (MarketWatch) — The Federal Reserve on Tuesday expressed much more concern about the economic outlook and said it would hold interest rates at ultralow levels “at least” through mid-2013, the first time the central bank put a time frame on their duration.

“They are saying the prospects are somewhat grim. They are saying hang it up for two years. That is about the best job of killing confidence that I have seen,” said Joel Naroff, president of Naroff Economic Advisors.

From left: Charles Plosser, Narayana Kocherlakota and Richard Fisher

The action brought strong dissent, as Dallas Fed President Richard Fisher, Minneapolis Fed President Narayana Kocherlakota and Philadelphia Fed President Charles Plosser objected to the specific time reference, instead of the old language of holding rates low for “an extended period of time.” Read First Take commentary on Fed move.

The last time there were three dissents was in November 1992, under former Federal Reserve Chairman Alan Greenspan.

The current chief, Ben Bernanke, led seven voters in favor of the decision, which came as the central bank said it expects a much slower pace of recovery than what it anticipated during the last meeting in late June.

“The FOMC now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting, and anticipates that the unemployment rate will decline only gradually” from the July level of 9.1%, the central bank’s statement said. “Moreover, downside risks to the economic outlook have increased.” Read the full FOMC statement.

The Fed also indicated that it “discussed the range of policy tools available to promote a strong economic outlook recovery in a context of price stability,” and said it’s prepared to employ the tools as appropriate. That could mean buying more bonds, or lengthening the duration of the debt it holds, Bernanke told Congress in July.

Stocks gyrated after the Fed decision but then the Dow Jones Industrial Average
DJIA, -0.05%
shot up hundreds of points, just a day after a 635-point nosedive. The Swiss franc surged as investors sought safe havens.

Gold for December delivery, which settled at a record $1,743 an ounce on the Comex division of the New York Mercantile Exchange, initially spiked higher before drifting lower by about $6 an ounce. Read more on gold in Metals Stocks.

Fed watchers will be looking for hints of a stronger easing move in Bernanke’s next speech on Aug. 26 at the central bank’s policy retreat in Jackson Hole, Wyo. Minutes of the Fed’s meeting will be published on Aug. 30 and will provide more insight into what was likely a sharp policy debate.

The statement came as the FOMC left its key interest rate at an historic low range of 0% to 0.25%, where it has been since 2008.

Paul Ballew, chief economist at Nationwide Mutual Insurance Co., said the Fed declaring its intention to keep its benchmark rate steady for two years is something “I never remember hearing” in his two decades as Fed economist and Fed watcher. “It is a reflection of how weak the recovery is.”

The market seems to be underwhelmed by the news, but “one has to wonder what magic bullet the market wanted,” he added.

By mid-2013, the Fed will have kept rates near zero for almost five years, Ballew noted.

Hawks on the central bank, like the three Fed dissenters, have not been as worried about the economy as Bernanke and his allies. They have been more wary of a surge of inflation from the Fed’s accommodative monetary policy.

The FOMC statement said the majority thinks that “inflation will settle over coming quarters at or below” the Fed’s implicit inflation target of 2%.

In the statement, the Fed said growth was much slower than expected and the labor market had deteriorated.

Saying they will leave rates lower for longer may give investors a clearer understanding of their intentions, and therefore more confident to make investments, said James Glassman, economist at J.P. Morgan Chase.

In the past few months, rates have risen when the economy looked like it was gaining traction, chocking off the recovery, he commented.

Lowered forecasts

The Fed’s last prediction for growth this year was in a range of a 2.7% to 2.9% annual rate. Growth was then expected to pick up to a 3.3% to 3.7% range next year.

The period since the last Fed meeting has been a horror show for the central bank.

Even before the steep market selloff after the United States lost its top-tier AAA credit rating from Standard & Poor’s, the Fed’s forecast for stronger growth was looking suspect.

The Fed had assumed the sluggish performance in January to June was due to high gasoline prices and supply shocks after the Japanese earthquake.

Instead, early indicators of third-quarter growth have been disappointing, and economists are busily slashing their growth forecasts for the remainder of the year.

GDP figures for the first half show growth at an average 0.8% annual rate.

Fears of a double-dip recession have increased, with Goldman Sachs saying the risk of renewed recession is one in three.

There is new concern that the plunge in stocks in the wake of the U.S. credit-rating downgrade will fuel a downward spiral of low confidence, weak spending and then lower confidence.

Economists at MarketWatch expect growth of 2.2% in the third quarter and barely accelerating to 2.4% in the final three months of the year.

Dean Baker, co-director of the Center for Economic and Policy Research, said this forecast near 2% would almost be as damaging for the economy as a double dip.

Indeed, economists surveyed by Blue Chip expect the unemployment rate to remain elevated be at 8.7% by the end of 2012.

Some prominent economists, including Ken Rogoff, professor of economics at Harvard University, think the Fed will ultimately enact another round of quantitative easing.

The Fed has bought $2.3 trillion in two rounds of quantitative easing, including $600 billion purchases of Treasurys that ended on June 30.

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